US dollar profit taking as gains deemed probably overdone
At the time of writing, the US dollar index is set to close lower this week after rising
by about 4% in the last three weeks. This is despite the fact that US economic data
releases this week exceeded market expectations. Indeed technical indicators imply
that the strength in the US dollar in recent weeks was probably overdone. Better than
expected China PMI, a recovery in crude oil prices also supported risk sentiment in
emerging market currencies. Sentiment in the Canadian dollar has also improved as
economic growth in Canada rebounded strongly in the third quarter. Nevertheless,
we expect the Canadian dollar strength to face strong resistance around the 1.301.32 region.
The euro rose to almost 1.07 as Italian bond yield spreads against German Bunds
narrowed. The latter was due to a report from Reuters stating that the ECB is ready
to step up purchases of Italian government bonds if the outcome of Italian
referendum this Sunday leads to a surge in bond yields.
Unwinding of speculative short positions continue to push the Sterling to above 1.26
against the US dollar. Brexit Secretary Davis said that the UK could consider making
contributions to the EU to secure the best possible access to the single market. This has
alleviated market concerns of a Hard Brexit when the UK triggers Article 50 in early 2017.

The Japanese yen also received some support around the 115 level as exporters
hedging activities pick up. Our assessment is that the weakness in the yen is
stretched as implied by real interest rate differentials between the US and Japan.
Indeed the currency options market demand to hedge against a weaker yen has
reversed in recent days.

Insights.abnamro.nl/en

2

FX Flash - US dollar strength…time for a breather - 02 December 2016

China FX reserves expected to decline in November…
China’s foreign currency reserves in November are expected to decline below the
USD 3.1 trillion mark, the lowest level since March 2011. This is due to valuation
effects (stronger US dollar in November) and narrow interest rate differentials
between China and the US. Since 8 November (US Presidential elections), the
Chinese yuan has declined from 6.78 against the US dollar to 6.92 before recovering
to 6.88 in recent days. However against currencies of China’s main trading partners,
the yuan has strengthened by about 1.5%. This implies that the yuan
underperformance was mainly due to US dollar strength rather than yuan weakness.
…measures to address speculative yuan outflows
Nevertheless, Chinese authorities have started to crack down yuan capital outflows
via false overseas investment activities via the ODI (Outward Direct Investment)
channel. Though this is a difficult exercise, Chinese authorities have been relatively
successful in closing the loop of ‘over invoicing’ via imports from Hong Kong. The
People’s Bank of China is also said to tighten rules on onshore companies lending
yuan offshore. Both onshore and offshore yuan interest rates have tightened
recently, which is also expected to limit depreciation pressures in the yuan. Our 2016
and 2017 year end USD/CNY forecast is 6.90 and 7.15. This is not materially
different from what is implied by one month (6.91) and one year (7.0960) nondeliverable forwards market.

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